All men’s miseries derive from not being able to sit in a quiet room alone. – Blaise Pascal

Posted by: donmihaihai | December 19, 2008

Evaluating management.

There is no simple way to do it, even Robert G. Hagstrom, author of “The Warren Buffett Way” put it that WB would be the first to admit evaluating management is more difficult than measuring financial performance. There isn’t any scientific way and people like me has a hard time trying. Still I like trying then giving up.

This post trigger by an exchange of email. Here is the meat.

REC is fantastic – more fantastic than Jaya – but i hv feel that it would be only fair to REC if the company were asked to comment on the points u raised. Then we get both sides of the story, so to speak.

Of course REC is more fantastic than Jaya. At any time, I would like to own REC than Jaya provided the price is right. REC education business is so fantastic that it keeps throwing out cash and the management is so good at managing as their design segment is becoming a franchise. BUT it is what the management did with their acquisitions that make REC vulnerable and stuck. That is lousy.

And when looking up at REC(or writing about REC),

1) I am not looking for “Madoff”. If REC is anything near “Madoff”, I guess I will lodge a report.

2) Neither am I looking for fairness. Ask shareholders of Lehman Brothers, Bear Stearns and AIG or FerroChina and China Print & Dyeing, do they have a chance now to say “Hey it is not fair” during whatever coming AGM or EGM? Shareholder, i.e. equity owner is the last one down the line, take all the hits when things happened. It is only reasonable to protect ourselves by looking at the businesses, financial statements and management.

3) It is about integrity, candid and transparency. Management commentary must matched by financial numbers. When they have good thing to say, great. BUT most will not say, “Hey, something is not working here or there.” The degree where management evaluating themselves, reporting to shareholders(especially the negative part) say much about integrity, candid and transparency. Also, it pays to see how management talk about those complicated deals that they entered into.

This is how I evaluate management. Not easy.

Anyway Jaya management is not much better, especially directors from Affinity Equity. Their “no interest” faces (except chairman) during 2007 AGM was a turn off. I am speculating that the almost double “vessel building program” and no mandate for share buyback despite stock price being selling at distressed level is partly due to them. I mean the building program increased after they came onboard and how can they, being in private equity specialist not understand buying back shares at this level benefit shareholder? I am also disappointed that not a single director showed that they are prepared if OSV slow or crash, everyone is enjoying the party. Despite these, I take comfort with pretty clean financial statements and management not entering into any sale-and-lease back deal, with one called those parties Norwegian dentist.

These few years, I come to admires Micro Mechanics not just as a company but the board of directors. I am learning from them too even during AGM. I would admit it is Chow Kam Wing, chief financial officer (CFO) of Micro-Mechanics comment in an article after winning CFO of the Year for companies in the Sesdaq (now Catalist) category that I finally make up my mind on sale-and-lease back for property in Singapore. This was what he said

‘We understand the semi-conductor industry is not a straight line business,’ he said . It is one of the reasons why the firm has paid up for its three buildings in Singapore, Malaysia and the United States. ‘If there is downtime, we just pay the salaries,’ he said. Having no debt is a buffer for the bad times, he added.

It is so simple. Why don’t I think of it earlier? As we are in downtime, maybe I can go and dig out listed companies who sold their properties to REIT, see how they are coping with the step-up rents. Here is another sign of prudence

As CFO, one of his jobs is to mitigate foreign exchange risks which can be a headache given that 44 per cent of sales is in t he US dollar which has been falling against the Asian currencies. But the group’s factories are based in Asia which is also fighting high inflation.

In 2006 the firm suffered a $97,000 forex loss. Since then he put in a simple hedging system. Every week, all sales are sold into forward contracts with the banks. In addition, the company tries to sell in local currencies.

‘It’s simple and conservative. We didn’ t listen to banks which tried to sell us some derivatives,’ he said. ‘I tell my boss, forex we can’t earn but we try to minimise the loss,’ he added.

During recent AGM, Mr Chow again commented that, they are remitting all cash back to DBS in Singapore as the credit market is falling apart because Singapore is the safest here and DBS has the backing of our government. Great but it is unwise to put all company cash into a single bank. He listened to shareholders and gets the message.

Again during the AGM, when asked what the reasons for buying AMP3 in US beside what are were already announced as AMP3 is lost making. CEO let COO answered. Mr Low gave his assessments and reasons with confident. And Independent Director Mr Ng weighted in by saying the board of director only agree after knowing CEO agreed to stay and manage AMP3. This board of directors, especially independent directors does not rubber stamp. Even with an acquisition that cost $2.22 million, 1/4 of FY2008 NPAT. Because of that, I really appreciate as knowing they shot down the idea of putting extra cash into a fund. In fact if I am not wrong, it was Mr Ng who shot it down.

Recently there was a proposal to invest the firm’s $13.5 million in cash in an investment fund to get better returns instead of just sitting in a fixed deposit account but the independent directors shot the idea down, he said. ‘They highlighted the risks,’ he added.

While it is not easy to evaluate management, at least reading local listed Micro Mechanics annual reports and all articles show the way.